What’s Your Pricing Strategy, Part I

We’ve talked a lot about how running a subscription business is different, and how flexibility in pricing and packaging is important for building and scaling a subscription business.

Often, people will approach us and ask, “That’s all great, but how do I know what type of pricing and packaging is best for me? Can you help us think that through?”

At Salesforce.com, we started with a simple per-user pricing model, and evolved it over time to include multiple editions ranging from Group Edition to Unlimited Edition, each with a different price point. Over the years, I’ve often been asked why we went with this price structure, and whether we considered other pricing models, such as per module pricing or usage-based pricing. You can follow some of that thinking in the talk I gave at Stanford University.

But to help people think through their own pricing, we typically bring it back to a discussion of their business objectives. These business objectives can vary based on a number of dynamic factors, such as current competition, capital needs, growth requirements, etc. Below I’ve listed the six most common business objectives we see, and how they shape pricing and packaging.

1. Target different segments: In 2000, we decided at salesforce.com that pricing would be simple: $65/user/month. We quickly found that this price was too high for the smallest of customers (e.g. the SOHO market), and that the large companies actually wanted to pay more for increased service and functionality. Sometimes, a fixed pricing model can alienate everyone. It’s important to offer each segment the right package at the right price.

2. Target different verticals: are you looking to get into a new vertical, or expand your footprint into a new geography? You could create a special service bundle for the public sector vertical, for example, or a new pricing structure for European customers. We recently talked to a company looking to get into the transportation vertical. The problem was, the new competitors in this space price differently, and had taught the buyer to expect a low monthly fee s for service, so a new pricing plan was in order.

3. Increase adoption: customer adoption usually spells more business—both new and repeat. Charging a flat fee typically encourages consumption (and adoption) of the service. A flat fee works well if you can combine it with an upsell model where you can sell additional services into the installed base, possibly priced on a consumption/usage basis. Netflix charges a flat rate of $8.99 for unlimited movie rentals per month. But if the renter wishes to hold onto more than one DVD at a time, he’ll have to upgrade to a more expensive plan. Another adoption strategy is to allow customers to build their own package to suit their own needs, making them much more likely to use your service. Once salesforce.com customers choose an edition, they can pick and choose add-on features that match their business needs, like a customer service portal, partner relationship management, or marketing campaign management.

4. Upsell: existing customers often represent low-hanging fruit for new revenues. SaaS company WebEx bills customers on usage of its Web conferencing service. Offering a tiered pricing system makes it easier to bump customers up to the next level, especially if they get charged for going over their limit. Another upsell strategy is to have a pricing model that scales as a company grows or gets more value from the system. So at Salesforce, a company can start with just 10 users, for example, but the sales rep can then monitor usage and encourage the company to add more users over time. We’ve spoken with companies that chose to have a simple pricing, say $1000/month, and our immediate reaction is, “Where’s the upsell?”

5. Collect cash upfront: if collecting cash upfront is your objective, then your pricing needs to support this. For example, a pure usage-based pricing model may seem attractive at first. The problem is, you don’t know how much to charge until after the fact, and so can only support billing in arrears. That makes it impossible to ask for a year worth of service up front. As another example, if you look closely at your cell phone bill, you’ll see that monthly service fees (say, for the 450 minute plan) are billed in advance, and overage prices (e.g. when you go over 450 minutes) are billed in arrears.

6. Reduce barriers to purchase: let’s face it—people are worried about the economy these days. They’re not comfortable shelling out a lot of money right upfront. Variable pricing can make it easier for them to get started. For example, variable pricing by contract period or calendar date feels less risky and provides value: $19.95/month for the first three months, and then $39.95/month. As another example, we recently spoke with a CEO who reported that where he used to be able to do multi-year contracts, now he’s seeing customers demand quarterly commitment and billing periods.

The hallmark of the subscription business is its flexibility. And as you can see, this flexibility allows you to achieve several business objectives with different pricing models. Next week, I’ll elaborate on the five common pricing plans that we see in recurring revenue businesses.